Mar 08, 2013 11:52 AM IST | Source: CNBC-TV18

Expect Sensex at 22,000 by 2013-end: Standard Chartered

The Indian market was weak ahead of the Budget, but has been quite volatile after that, with earnings growth now being the main cause of uncertainty, says Clive McDonnell, head of EM equity strategy at Standard Chartered Bank, speaking to CNBC-TV18.

The Indian market has been quite volatile after the Budget, with earnings growth now being the main cause of uncertainty, says Clive McDonnell, head of EM equity strategy at Standard Chartered Bank.

Bullish on US equities, he says, the market is looking at the potential for earnings upgrades. He believes the market in the US will continue to rally, hitting new highs.

In Asian matkets, though, there is still some uncertainty prevailing.

Here is the verbatim transcript of the interview

Q: It has been a volatile couple of days for the market - up again, down again. How have you read it first in terms of risk on levels right now?

A: In the global context, we have seen the VIX come down quite a bit, relative to the levels on Monday this week. For India, the market was weak ahead of the Budget but after has been quite volatile. Investors are trying to assess what is the impact on earnings growth this year. It is the main thing that is creating uncertainty currently for the Indian market.

Q: How do you think the wind might blow for global equities over the next few months? Do you think the US continues to power ahead into new highs or do you expect turbulence?

A: In the near term, obviously issues associated with the Budget or this sequestration is creating uncertainty for economists in the US and indeed globally. From an equity market point of view, clearly the market is looking at the potential for earnings upgrades going forward, as well as the impact that M&A could have valuations in terms of premiums on the market going forward. So I would certainly see the market in the US continuing to climb, hit new highs. In Asia, though, there is still some uncertainty. That holds true in India in terms of earnings outlook, and also in China in terms of the outlook for property in the bank sector.

Q: How is India looking from a relative perspective? This year has not been great from a relative standpoint. Do you expect this underperformance to continue or will India catch up?

A: India does have the potential to catch up. If you look at valuations of India relative to China, historically India tends to trade on about 20 percent premium to the Chinese market. But that climbed to 30 percent last year. Now it has come back a little bit, probably 26-27 percent at the moment, but India is trading above its long-term average in terms of premium over the China market. So China can outperform, but in an absolute sense, India can continue to do well. We are little more optimistic in terms of the outlook for earnings compared to the market.

Q: We haven’t had a great start to the year. Tactically, are you buying into India right now or do you think that price point may come a bit later?

A: Near term given the uncertainty over execution of infrastructure spend and also the outlook for earnings, there may be some lower entry points for trading-oriented investors. So if one has a short-term horizon of weeks instead of months, then a better entry opportunity is likely to come. But for banks and for other investors looking long-term, we think that the market looks attractive at current levels.  But again I want to emphasise, looking at India relative to China, we think China can do better, but in absolute sense India can continue to climb. We have an index target looking about 22000 towards the end of the year.

Q: What is the central risk to India as a market? Is it a turn or a change in terms of global flows and sentiment towards emerging markets (EMs)? Or do you think it is local problems which people have been worried about, like the weak gross domestic product (GDP) print that we had, or the extremely poor earning season we have put behind us?

A: Last year, the market discounted the weakness in terms of Indian economic growth. I don’t think that is a driver in near term. The bigger issue for India is the flows picture. Now if you see a reversal in terms of portfolio flows, that would definitely negatively impact the market. Year to date, we have had about a USD 31 billion flow into EM equities which is a very strong number for the first two months of the year. But last year, we had about USD 48 billion flow in. 

So we are off to a very strong start, but we did see the first cracks emerge last week. Last week, about USD 1 billion flowed out of emerging equity and we have seen some markets cracked on the back of that, as well as domestic issues. So flows are the bigger risk for EM equities in the year ahead.

Q: What does India’s ownership pattern suggest now, because last year a lot of under-ownership of Indian equities changed? By the end of the year, most funds had recalibrated to a fair amount of weightage or even in some cases overweight. From that point of view, do you see India getting a large amount of flows this year or is it vulnerable to some outflows?

A: I do think it is vulnerable to outflows from the emerging markets. Not specifically if investors withdraw from India, but if flows come out of emerging markets, then India is the most sensitive to that. In terms of allocation, you are right. In terms of foreign investors, despite the weakness in the market last year, we saw an increase to a healthy overweight position and the drag on the market is that the foreign buying is met with fairly persistent local selling.
So, the swing factor probably in the year ahead is if local investors as well either begin to agree with the foreigners, or remain net sellers as we saw last year.


Q: You think we will go through at least another quarter of pain like the one that we came out of because we have not seen any meaningful upgrades happening for earnings yet?


A: Our own lead indicator for earnings, the Earnings Revision Index, did take a pause in February. It has been quite strong since August-September last year. We have seen the earnings revision numbers improve. As you pointed out, the delta has not seen a lot of upgrades, but roughly about 14 percent for FY13-14 in terms of earnings per share (EPS) growth. I think for analyst upgrades from here, we need to see greater confidence around the issue of execution, greater clarity in terms of the rate outlook and the impact on the banks’ net interest margins. That is also a big swing factor for the market in terms of earnings for FY13-14.


Q. Do you think returns are going to be mostly back-ended for the market this year because there are some concerns about how elections etc in India may actually stifle performance in the second half?


A: In terms of the market, we are looking at greater gains in the second half. The government has managed expectations certainly in the run-up to the Budget, but heading into the elections, I would expect to see some improvement in terms of growth. The government has come through policy missteps and other factors, growth has slowed down. The market has discounted that as I say. Our economic forecast looks to see some improvement next year, and if the market begins to agree with that, that would be some of the factors that would enable us to move to 22000 numbers. It is probably more of a second-half target as opposed to first half.


Q: How important a role are currencies playing in the decision on Ems, because the dollar index says that 82 plus. We have seen the depreciation on the rupee. Do you think that is going to be an important moving factor for deciding on investment in EMs?


A: Historically, the dollar and portfolio flows are negatively correlated. The dollar index has moved substantially higher year-to-date from 79 to 82. Now, traditionally that would coincide with an outflow of funds from EMs. But year-to-date, we have seen about USD 31 billion flow in. So there is a big question mark about what is happening with regard to that relationship. And our view is that structurally the period of dollar weakness is behind us. For a lot of the models, the relationship between the dollar index and the fund flows look back over the past seven years. And that has coincided with persistent structural dollar weakness.


However, going forward, we are of the view that the dollar structurally is going to be on an improving trend helped by a narrow fiscal deficit and an improvement in the current account deficit. That structural change implies that there may be also a change in the relationship between the dollar and portfolio flows. That is, the fact that we get a stronger dollar is not necessarily negative for portfolio flows as has been the case over the past seven years, because of that structural change taking place. In the longer term, the outlook is for the dollar to appreciate now.

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